Melbourne investors should look for high rental yields, not capital growth, in the short term: Tim Lawless

Investors considering buying in Melbourne should focus on areas where rental demand is strong as the outlook for capital gains over the short term remains weak, according to RP Data national research director Tim Lawless.

Lawless says “[rental] yield maximisation will be the main game for most investors until capital gains start to become apparent again”.

“Most investors should realise that capital gains are not going to be apparent for some time – the market came out of the growth phase around June last year, so we should expect capital gains to be relatively weak over the next year at least,” he writes in The Age.

Besides the potential for rental growth, Lawless says investors should also seek areas “ripe for long-term capital gains”

“Suburbs close to the city that are not reliant on foreign students are likely to be popular, as will be suburbs close to major working nodes and captive rental populations, such as universities and hospitals,” Lawless says.

However, investors will have to search hard to find a Melbourne area where the potential for rental growth is strong.

The city currently has the lowest rental yields of any capital city in Australia, with Melbourne houses returning an average gross rental yield of just 3.8%, with units only slightly better at 4.3% (The combined capital city benchmark is 4.3% for houses and 5% for units, according to RP Data).

Over the past 12 months, the weekly rent on an average Melbourne house increased by just 1.9% to $398 while weekly rents for units increased by just 0.9% to $363, growth well below historical annual rental increases in the Melbourne metro region of 6.5% per year.

When taking inflation into account, it is now cheaper to rent a house or unit in Melbourne than it was a year ago.

According to Lawless, part of the reason for Melbourne’s soft rental market has been an oversupply of housing.

“In the year to September, there were 65% more dwelling approvals in Victoria than in New South Wales, despite the two states having roughly the same level of housing demand as measured by raw population growth.

“The number of land sales in the Melbourne metro region is more than double what was recorded in the Sydney region, once again despite both having similar population growth,” he says.

Lawless says demand for apartment rentals is also being affected by a drop in overseas student numbers, which are well down on the highs of 2008-09.

“According to the Department of Immigration, there were 366,000 student visas lodged in Australia in 2008-09. In 2009-10, 282,000 student visas were lodged – a drop of about 30%,” he says.